£200bn to save banks from bad debt

The taxpayer will be forced to underwrite up to £200 billion of bad banking
debt under a government plan to take control of assets belonging to
Britain's major high street lenders, The Daily Telegraph can disclose.

In an attempt to restore confidence within the financial sector, the Treasury will tell the banks of its plan on Saturday. It aims to announce details of the rescue package publicly early next week.

The bad bank plan has climbed the political agenda in the past couple of weeks as the Government has become aware of the extent of the lenders' bad debts.

Sources said that a bad bank would have to take on about £200?billion of toxic assets. That would take the Government's total commitment to solving the banking crisis to almost £1?trillion in taxpayers' money that has either been spent or pledged.

That equates to about £33,000 per taxpayer. The total sum is equivalent to more than two-thirds of Britain's annual GDP of £1.4 trillion.

The £1 trillion figure includes the £500 billion announced in October to buy shares in the banks and to guarantee their debt. It also includes a further £100 billion fund, which will also be announced next week as part of the rescue package, to provide the banks with cash to lend to ordinary customers and businesses.

As well as creating a bad bank, the Government is planning to use Northern Rock as a "good bank" which can dramatically increase lending to individuals and businesses.

The banking crisis has deepened in recent days on both sides of the Atlantic. Barclays shares fell by 25 per cent yesterday on fears that the Government would force it to take part in the bad bank. Citigroup said it was to split itself in two to ring-fence its failing assets after disclosing £20 billion of losses in the past 15 months. Bank of America received a £14 billion cash injection from the US government.

In the US, similar government measures are being discussed, with officials looking at either the prospect of a "bad bank" scenario, or extending individual guarantees to banks that need them.

The situation has been being assessed by members of outgoing President George W. Bush's administration in recent weeks, in close contact with members of President-elect Barack Obama's transition team, who will take over the US Treasury and other key departments after his inauguration on Tuesday.

As he finalises the details of the rescue plan with the Treasury, Gordon Brown will this weekend attack the "irresponsible" lending of British banks to foreign nationals and overseas companies.

City sources said last night that the talks over the setting up of a bad bank were "highly complex" and that there was still strong opposition among banks to the Government enforcing a compulsory seizure of their assets.

A more attractive option for the banks would be to keep the assets on their own balance sheets but ring-fenced. The Government could then offer a guarantee on those assets in order to provide confidence to investors.

The more likely option – which is favoured by the Treasury and City regulator, the Financial Services Authority – is to create a toxic bank. They see this as the best way to cleanse the banking system and set it on a path to recovery.

Banking sources said they expected to be given an outline of what the Government plans to do on Saturday afternoon. There will then be intensive negotiations between the Treasury and individual banks over which assets must be put into the bad bank and at what price. The process could take several weeks to complete.

The major users of the toxic bank will include Royal Bank of Scotland, in which the Government already has a 60 per cent holding. RBS is understood to have been forced to write off a £2.5?billion loan to a Russian oligarch.

Lloyds TSB, which has bought rival HBOS, will also take part in the scheme. HBOS was forced to sell itself to Lloyds last year after buckling under massive losses in its corporate lending book. The Government owns 43 per cent of the enlarged Lloyds bank.

More controversial will be the position of Barclays and HSBC. Neither bank took cash from the Government as part of the October bail-out, and Barclays instead raised money from a group of Middle Eastern investors.

However, it is believed that they will be forced to join the bad bank so that the entire banking system can be shown to be purged of problematic investments.

The Government will keep the toxic assets in the bad bank and, when the economy improves, will hope to sell them off over time.

The other key aspect of the rescue plan is the £100?billion in Government-backed loans that will be offered to banks.

The money will be used by banks to fund new loans for home owners and businesses.

The package is effectively a way of underwriting bank lending. Taxpayers' money could be at risk if home owners or businesses fail to repay their debts to the banks and the banks therefore struggle to repay the Government.

The latest rescue package comes after Mr Brown introduced a £500?billion package of aid for the financial sector in October. Despite the scale of that package, business leaders say banks are still not lending freely, threatening many companies with collapse.

Government insiders say the banks are refusing to lend because of the scale of their toxic assets – loans based on properties whose prices have collapsed – and face further major losses in the coming months.

Downing Street has been angered by the mounting evidence that there was widespread reckless lending by the high street banks that precipitated last year's financial crisis. Mr Brown is understood to be concerned that up to 80 per cent of the bad debts at some banks were to foreign companies or individuals.

There were signs last night that America was looking at a similar "toxic bank" scheme. Advisers to Barack Obama, the President-elect, are reportedly considering such proposals.